Stablecoins and US Treasuries: An In-Depth Analysis
Wall Street is buzzing with debate over whether stablecoins, empowered by landmark US legislation, can truly bolster the US dollar's dominance and become a significant source of demand for short-term US Treasury bills (T-bills). Despite varying viewpoints, strategists at firms like JPMorgan Chase, Deutsche Bank, and Goldman Sachs generally agree that it's premature to declare stablecoins a "game changer," regardless of how optimistic former President Donald Trump and his advisors might be about stablecoins becoming a new pillar of American finance. Moreover, some see inherent risks.
Skepticism Prevails
Steven Zeng, US market strategist at Deutsche Bank, suggests that projected stablecoin market size is overblown. "Everyone's watching, but no one dares to make a directional bet," he says. "There are plenty of skeptics."
What are Stablecoins?
Stablecoins are digital tokens pegged to the value of traditional currencies, most commonly the US dollar. They offer lower volatility compared to market-driven cryptocurrencies like Bitcoin. Functioning as a digital equivalent of cash on the blockchain, they can be used for digital storage, instant transfers, or transactions, much like a bank account.
Impact of New Legislation
Since the passage of the "Genius Act" stablecoin legislation in July, industry proponents have hailed it as a crucial breakthrough, paving the way for broader adoption of dollar-denominated digital currencies within the financial system. Former US Treasury Secretary Scott Bessent estimated that the legislation could propel the dollar stablecoin market from its current ~$300 billion to $3 trillion by 2030.
Easing Pressure on Interest Rates
Under the new law, stablecoin issuers must maintain 100% reserves fully backed by short-term Treasuries and other cash equivalents. Bessent believes the impending demand "surge" triggered by stablecoins will enable the Treasury to issue more short-term debt, reducing reliance on longer-dated bonds and easing pressure on mortgage rates and other borrowing costs tied to longer-term benchmarks.
Relatively Small Player
Currently, dollar stablecoins (primarily Tether's USDT and Circle's USDC) already hold approximately $125 billion in US Treasuries, close to 2% of the outstanding short-term Treasury market at the end of last year (Kansas City Federal Reserve study, August). According to the Bank for International Settlements, these issuers purchased around $40 billion in short-term Treasuries last year alone. However, stablecoins remain a "small player" compared to US money market funds, which hold roughly $3.4 trillion in government debt.
Diverging Growth Forecasts
Most analysts believe that the stablecoin market will definitely expand under the regulatory framework gradually taking shape in the coming year, but forecasts diverge significantly. JPMorgan Chase anticipates the market will grow to, at most, $700 billion in the coming years, while Citigroup's optimistic forecast goes as high as $4 trillion.
Potential Challenges
The ultimate goal of crypto industry proponents is for stablecoins to become a mainstream payment method, directly challenging the traditional banking system. Small and medium-sized banks are particularly concerned about deposit outflows leading to credit contraction, while larger banks plan to issue their own stablecoins, profiting from interest on reserves.
Growth Constraints
Even if the most optimistic growth forecasts materialize, the actual boost to Treasury demand may be far lower than anticipated. Skeptics point out that inflows into stablecoins primarily come from four sources: government money market funds, bank deposits, cash, and overseas demand for dollars. Since the "Genius Act" prohibits paying interest on stablecoins, investors seeking yield have little incentive to move funds from savings accounts or money market funds, limiting its potential growth.
Net Zero Effect?
Even if investors do shift funds from money market instruments (currently the largest buyer of short-term Treasuries), the net effect may be zero: rather than creating new demand for short-term Treasuries, it merely changes the identity of the holders.
The Federal Reserve's View
Stephen Miran, White House chief economist and current Federal Reserve Governor, acknowledges that domestic demand for stablecoins may be limited, but believes the real opportunity lies overseas – where investors are willing to accept zero yields in exchange for exposure to dollar assets. He suggests that dollar-denominated stablecoins will attract overseas demand.
Global Competition
European central banks are developing their own digital currencies to counter competition from private dollar stablecoins. Goldman Sachs analysts point out that capital controls restricting access to traditional dollars are also likely to apply to dollar stablecoins.
The Federal Reserve Factor
Another factor that could weaken the impact of stablecoins on Treasury demand is the Federal Reserve itself. Michael Cloherty, strategist at CIBC, points out that if stablecoins "sequester" circulating dollars (liabilities on the Fed's balance sheet), the Fed would need to reduce its asset size accordingly, including its $4.2 trillion Treasury portfolio. This means that "most" of the Treasury demand brought by stablecoins might simply replace Federal Reserve holdings.
Risks of Short-Term Debt Reliance
Over-reliance on short-term debt could come at a cost: reduced predictability of government funding, the need for more frequent debt rollovers, and increased vulnerability to changes in market conditions.
Conclusion
In conclusion, it is too early to definitively say that stablecoins will revolutionize the US Treasury market. While the market is expected to grow, its actual impact on Treasury demand may be limited due to various factors, including competition from other investment vehicles and Federal Reserve policies.
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